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Recent Research: Highlights from May 2014

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"Constraints and Innovations for Pension Investment: The Cases of Risk Parity and Risk Premia Investing"
The Journal of Portfolio Management (Spring 2014
Wai Lee

In the current low real-yield environment, institutional investors are challenged as they try to achieve their often-fixed targeted returns within the confines of their investment policy guidelines. If much-discussed solutions, such as risk parity and risk premia investing, are the new answers, they must improve portfolio efficiency and flexibility in taking risks. This article explores the ways these proposed solutions may be successful. The author argues that the solutions neither introduce new assets that offer non-replicable, non-redundant return and risk characteristics, nor do they offer new asset-pricing theories that improve forecasts of asset returns or risks. Instead, their value proposition is more in the category of improved portfolio construction. They primarily benefit practitioners by providing more-efficient risk allocations, which they do by relaxing constraints to which pension investors are often subject, including restrictions on using leverage and short selling.

"The Institutionalization of Family Offices in Brazil"
The Journal of Wealth Management (Summer 2014)
Caroline de Oliveira Orth, Clea Beatriz Macagnan, and João Zani

This study identifies the organizational characteristics of family offices (FOs) in Brazil. This article was developed through a content analysis of 22 interviews conducted with persons involved in 13 different FOs, two family enterprise executives, and one private banker. The study’s relevance relates to changes in Brazil’s economic structure, which have principally been caused by an increase in companies going public and in merger and acquisition transactions. These changes have contributed to increasing the volume of resources available for investment by families that retain control of the affected organizations. These families have begun to search for mechanisms to preserve their private property within the structure of FOs. This study also revealed that MFOs seek to provide multiple business families with differentiated services within their areas of activity. However, one must question the extent to which these organizations simply take advantage of the FO concept for marketing purposes. In contrast, SFOs are primarily established by Brazilian business families to separate company affairs from family matters, thereby increasing the professionalization of the family business. Moreover, because of the complexity of tax-related issues in Brazil, certain families create SFOs because they wish to optimize their tax statuses. The desires to resolve questions of succession and to implement financial resource management also motivate the creation of FOs in Brazil.

"Can Collars Reduce Retirement Sequencing Risk? Analysis of Portfolio Longevity Extension Overlays (LEO)"
The Journal of Retirement (Spring 2014)
Moshe A. Milevsky and Steven E. Posner

Practitioners are well aware of the pernicious effect of the “sequence of investment returns” on retirement income sustainability. Poor markets early in the withdrawal phase increase the “lifetime ruin probability” and reduce the longevity of a portfolio. In this article, the authors investigate how and when traded equity options can be used to extend the life of a retiree’s investments. They label this class of strategies longevity extension overlays (LEOs) and use simulation techniques to analyze the strategy’s theoretical properties. They also provide evidence on the efficacy of simple LEOs during the 2007–2013 period. Our results are encouraging and offer a justifiable alternative for wealth managers who want to avoid using (more complex and opaque) insurance-product solutions.

"The Final Volcker Rule—Impact on Securitization Transactions"
The Journal of Structured Finance (Spring 2014)
J. Paul Forrester, Carol Hitselberger, J. Bradley Keck, and David Sahr

On December 10, 2013, the Federal financial agencies issued the joint final regulation implementing Section 619 of the Dodd–Frank Act, commonly known as the “Volcker Rule.” This article addresses the impact of the final regulation on securitization activities and therefore focuses on the prohibition on covered funds activities and certain of the exceptions thereto. The final regulation provides for 14 separate exclusions from the definition of covered funds, including the loan securitization, qualifying asset-backed commercial paper (ABCP), qualifying covered bond, and wholly-owned subsidiary exclusions. Although securitization transactions generally do not utilize entities that would be regarded as private equity funds or hedge funds and the statutory text of the Volcker Rule expressly required that the final regulation not prohibit the securitization of loans, the final regulation will impact certain securitizations in a material way due to the breadth of the definition of covered funds.

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